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PICKING UP THE GAUNTLET

PICKING UP THE GAUNTLET
On 4 September, with the economy in tatters, Raghuram Rajan took the stage as the new governor of the Reserve Bank of India. The rupee was hovering close to 70 to a dollar (68.85) and investors were leaving the country in droves. The UPA-II government had seemingly lost control of the mother ship, as inflation and the current account deficit continued to rise (4.5%). Growth projections were low and Dalal Street looked downbeat.

However, on 4 September, some of that drastically changed for the better. In what the Indian media called, ‘the Rahguram Rajan effect’, his first speech as India’s new RBI governor, set the tone for positive sentiment that flowed through the Indian markets. The Sensex rose, by gaining 1,000 points in close to three days, to hover above 19,000 points. The rupee, regained its value significantly, as it touched the 63 to a dollar mark on Wednesday.

The son of an Indian foreign service officer, Rajan passed through India’s elite institutions, IIT-IIM, with flying colours. He earned his doctorate from the world renowned Massachusetts Institute of Technology (MIT) for his thesis titled, ‘Essays on Banking’. Since then, his career has touched remarkable heights. He was appointed as the youngest-ever economic counselor and director of research (chief economist) at the International Monetary Fund (IMF) between October 2003 and December 2006.

However, it was in 2005, during the celebrations of the then retired US Federal Reserve chairman, Alan Greenspan, that Rajan presented a controversial paper called ‘Has Financial Development Made the World Riskier?’ In the paper he talked about the impending sense of doom facing the US financial markets, unless certain measures were brought in.

He argued that financial sector managers in the country were, ‘encouraged to take risks that generate severe adverse consequences with small probability but, in return, offer generous compensation the rest of the time. These risks are known as tail risks. But perhaps the most important concern is whether banks will be able to provide liquidity to financial markets so that if the tail risk does materialise, financial positions can be unwound and losses allocated so that the consequences to the real economy are minimised.’

The response he received for his paper was scathing. In throwing a wet blanket Alan Greenspan’s pro-free market enterprise, with virtually no regulatory oversight, Rajan challenged the dominant discourse. Former US treasury secretary and former Harvard president, Lawrence Summers called the warnings ‘misguided’ and called Rajan a ‘Luddite’. However, in 2008, when the financial markets came crashing down, everyone saw the wisdom in Rajan’s warnings. In January 2009, the famed Wall Street Journal said that as of then, ‘few are dismissing his ideas’.

Meanwhile, in 2008, Prime Minister Manmohan Singh tasked Rajan to ‘advise’ the Planning Commission. The final report, titled ‘100 Small Steps’, comprehensively laid out a strategic roadmap to modernise the failing financial system of India. It was a report, widely hailed by critics, as  that of a reformer who was unafraid of putting forth bold ideas. With Pranab Mukherjee’s largely unsuccessful tenure coming to an end in 2012 as finance minister and Manmohan Singh having oversight over it till the return of P Chidambaram, Rajan was swiftly brought in as chief economic advisor. Till the time he was made governor, Rajan strangely held himself back from the unabashed reforms he put forward in 2008. Instead, many critics believed that he tended to toe the government line in matters of policy.

However, with his appointment as the new governor of the RBI and the evidence put forward by his inaugural speech, he seems to have gone back to the well. In drawing the waters of much-needed reform, a sense of hope has begun to emerge. No one is really too sure as to how he will proceed with some of the steps that he has put forward, till the RBI policy meeting on 20 September, which will be preceded by the Federal Reserve’s Open Market Committee (FOMC) meeting on 17-18 September. But like a fleeting moment of happiness, that good feeling remains for the time being.
The key to tempering market sentiments is the ability to communicate clearly, in terms of the key steps that are going to be taken. As simple as it may sound, this has never really been a salient feature of our administration, past and present. Rajan articulated that clarity of thought. There was a clear agenda in place. He was absolutely clear that there was no going back on the process of liberalisation. Despite certain elements of the Chicago School (usually considered to be free market practitioners), coming into his policy outline, there is an element of responsibility too.
Some of his ideas include steady liberalisation of markets and lift restrictions on investment and position taking, together with SEBI (Securities and Exchange Board of India). One key innovation he outlined was his ideas on foreign currency non-resident account deposits (FCNR). Rajan’s first few measures include a swap window facility for banks to lure in NRI funds and reversal of some of the controls that his predecessor D Subbarao had introduced. This would essentially, solve some of our foreign currency shortfalls, which according to Rajan would, ‘help our banks bring in safe money to fund our current account deficit’. 

The liberalisation of the banking sector, an area where he is as formidable as they get, has given markets much to be pleased about. His idea towards opening up the Indian banking sector to greater foreign competition is allied with greater regulatory and supervisory control over the domestic operations of foreign banks by the RBI. Another measure brought in is that banks need not require RBI’s nod to open new branches in the country.

Despite all the positivity surrounding Rajan’s plans, there is an element of apprehension as to how these policy outlines will manifest into an ailing economy.
Traditionally, institutional heads in India tend to downplay some of the promises they make, while attempting to deliver something more. This is primarily because they inherently understand some of the deep-rooted structural problems that lie within that entity. However, more importantly, rising through the ranks of such institutions, mired in administrative and bureaucratic hurdles, creates its own sense of cynicism.
Rajan, fortunately, doesn’t carry that baggage. In an institution that does revel in a sense of autonomy, he could well instigate a fresh approach to an institution often seen as resistant to change. Inexperience in handling such bureaucratic structures  could either work in his favour or it could be an impediment. But one key hurdle, like all past governors, would be his ability to balance between the government’s desire for fiscal expansion, while keeping interest rates low and yet manage inflation. This point of tussle has inevitably led to a souring of relationships between existing finance ministers and RBI governors. The manner, in which he toed the government line as chief economic advisor, shows there is a ‘political animal’ in him. Will that flow over to his tenure as the RBI governor? Or will he instigate a new era in this revered institution?

The challenges are many, with numerous pitfalls yet to come across. Our economy is still in a mess, despite a recent incremental upsurge.
One such challenge is the difficult task of bringing our current account deficit (CAD) down to $70 billion in the current fiscal, from $88.2 billion last year. The rising cost of crude oil import will continue to put pressure on the CAD. Despite the recent rise in the rupee, the rising CAD means that the rupee is still not out of the woods. The other major challenge shall emerge from what transpires at the FOMC meeting on 17-18 September. The Fed’s decision to ease its quantum of monetary stimulus could have major repercussions on India’s economy. The economy is a major beneficiary of the Fed’s loose monetary policy, resulting in huge foreign capital inflows that are used to bridge our CAD. 

Due to Rajan’s initial blitz, expectations from him to bring the economy back onto the trajectory of high growth have risen significantly. Before he can reach there, there is still a long way to go towards complete recovery. It is a good start. But it is only the start. Let us wait and see what transpires. The clouds have become less heavy, but the conditions for our economy still remain overcast. We are still waiting for the sun to come out. Let us see if Rajan walks us into the sunlight.

Rinchen Norbu

Rinchen Norbu

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